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Street Authority

Waste Management Companies: Defensive Dividend Stocks for Uncertain Times

August 05, 2011 | About:

This industry is never going away. And even when the economy struggles, such as is the case now, stocks in this industry rarely disappoint investors. They provide consistent dividend payments at growing rates and can be great defensive plays.

I'm talking about waste management companies -- a reliable and profitable industry that has been meeting growing demand as population growth and consumption increases and recycling becomes an important practice. Even during the worst recessions, people continue to produce waste, which must be collected and processed. In the United States alone, waste management is a $52 billion industry that's growing faster than the country's gross domestic product.

Garbage-collecting companies benefit from reliable, annuity-like income streams, which are the result of multi-year contracts with customers that are service-based rather than volume-based. In addition, dividends are secured by generous cash flow, which are often two to three times greater than earnings. The combination of a cash-rich business and predictable results creates a formidable engine for consistent dividend growth.

Waste-management companies also benefit from high barriers to entry, which keeps competitive threats low and pricing leverage high. The costs and time involved in developing a new landfill are immense. Securing the necessary permits can take up to seven years, and the process has become even more burdensome following the passage of Subtitle D to the RCRA (Resource Conservation and Recovery Act), which establishes minimum federal technical standards for landfills. New regulations have forced many landfills to close, making the remaining permitted sites even more valuable.

In the past decade, waste-management companies have also developed a major new source of revenue from recycling. The volume of plastics, aluminum and other scrap materials recovered from garbage in the United States has increased from 70 million tons a few years ago to more than 82 million tons today, according to U.S. Environmental Protection Agency estimates. And because prices for aluminum and other commodity metals are skyrocketing, recycling is becoming increasingly profitable for these companies.

There are two cash-rich garbage management companies with hefty dividends that are likely to hold up well even in the worst of times. Here they are...

Republic Services Inc. (NYSE:RSG)

Yield: 3%

Republic Services provides waste-collection services for businesses, homes and municipalities in 40 states and serves more than 2,800 municipal customers. The company acquired a major competitor, Allied Waste, two years ago and now operates roughly 190 municipal waste landfills, putting it second only to Waste Management, which has about 270 sites. Bill Gates, through Cascade Investments, his private asset management firm, owns about $1.6 billion of the stock (Cascade also owns shares of Waste Management, although in a smaller $587 million stake).

Republic enjoys a monopoly in 30% of its markets and has an exclusive multi-year contract providing waste-collection service to one of the country's fastest-growing cities, Las Vegas.

Helped by lower expenses, earnings-per-share (EPS) rose 14% in this year's second quarter to $0.49 per share. The company also confirmed full-year 2011 earnings guidance and free cash flow at the high end of the $875 million to $900 million guidance range.

Republic has raised dividends nine years in a row. In the past five years, the dividend has increased 18%, while payments were increased by another 10% in July to a $0.80 annual rate. Dividend payments, totaling less than $300 million in 2011, are comfortably covered by $900 million of free cash flow.

Analyst say Republic can deliver 15% yearly growth during the next five years. Consensus estimates expect this company to grow faster than Waste Management, because its markets are growing faster. The company generates more than half of its revenue from states with above-average population growth, such as Nevada and Arizona.

Republic shares, however, are more expensive than Waste Management's. The stock carries a price-to-earnings ratio of 18.5, but is valued at 13 times forward earnings. Republic shares currently yield about 3%.

Waste Management (NYSE:WM)

Yield: 4%

Waste Management is the nation's largest provider of garbage collection and disposal services, serving nearly 20 million residential, commercial and municipal customers. The company is also the country's largest owner of municipal landfills, a strategic advantage even more valuable as availability of landfill space disappears.

Analysts expect Waste Management to produce annual EPS growth of more than 10% in the next five years through a combination of volume capacity growth, modest price increases and acquisitions. The company has been acquiring smaller, private garbage operators for several years -- in the past month alone, it acquired two electronics-recycling businesses and smaller rival Oakleaf Global Holdings.

In the past five years, Waste Management's EPS growth rate has been about 3% a year, while dividends have grown above 9% a year. The last dividend increase came in December 2010, when Waste Management raised dividend payments by 8% to a $1.36 annual rate -- the company's seventh straight year of dividend increases. Waste Management expects to generate free cash flow exceeding $1.25 billion this year, which should easily cover its $650 million in dividend payments.

Waste Management shares fell by nearly 16% in July after the company reported second-quarter per-share profits of $0.54, up 6% from the year-ago quarter, but a penny under analyst estimates. In addition, the company cut its full-year 2011 earnings guidance, citing weaker-than-expected volume. As a result, the stock appears bargain-priced right now at 16 times earnings, near a five-year low. Dividend yield is also attractive at just over 4%.

Action to take --> Waste Management and Republic offer safe, growing dividends in an uncertain market. Waste Management has a higher yield, but Republic will likely increase dividends at a faster rate. In addition, the fact that Bill Gates owns shares of these big players should be a good sign that these are two solid holdings.


Lisa Springer

About the author:

Street Authority
Charlie Tian, Ph.D. - Founder of GuruFocus. You can now order his book Invest Like a Guru on Amazon.

Rating: 2.3/5 (19 votes)


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